Electricity System Costs in the UK, Denmark, and Germany

Date: 31/01/16

Dr John Constable: GWPF Energy Editor

On the 27th of January last week the UK’s Department of Energy and Climate Change announced the conclusion of the latest auctions for Demand Side Response, one of several transitional instruments currently being used ahead of the introduction of the Capacity Mechanism, to address tight margins of electricity generation over peak load.

803 MW of capacity in the winter 2016/17 was bought for £27.50/kW, giving a total cost to the consumer of about £22m. Figures of this order may seem like a pin-prick in a sector so large, but the fact that such emergency costs need to be imposed at all is in itself remarkable, and a clear indication that the UK’s energy and climate policies have created electricity system management problems that were not anticipated by government, and the significance of which has until recently been treated as minimal by the renewables industry and sympathetic academics.

Moreover, these charges are a sign of things to come. The Office for Budget Responsibility has predicted that the Capacity Mechanism will cost some £600m in its first year, 2018/19, rising to £1.1bn in 2019/20, and then to £1.3bn in 2020.[1]

The necessity of these actions was explained by the Secretary of State for DECC, the Rt Hon Amber Rudd, MP, in her speech of November 18 last year, when she observed that “We now have an electricity system where no form of power generation, not even gas-fired power stations, can be built without government intervention.”[2] Implicit in such a statement is the admission that this problem must be creation of other state interventions. After all, energy is not a ‘public good’, and will be spontaneously supplied by the market unless that market is distorted. And of course it has been distorted. A combination of EU Directives and their UK implementations has conspired to reduce Combined Cycle Gas Turbine load factors to, as DECC itself reports, around 30%,[3] when they are perfectly capable of running at 90%. This is hardly encouraging for investors in the plant that will be required to replace coal generators now on the verge of closure.

Revealing though these emergency measures are, their significance is broader still, since they provide clear evidence of a tendency to reduce that part of the consumer price that is decided by wholesale markets. Many charges on the consumer are now quite invisible to the markets, or determined in airless, government managed events, such as the auctions reported last week. This is extremely undesirable, and reveals a deep contradiction at the heart of European energy policy, which on the one hand is, laudably, urging market liberalization, while on the other, and principally through its climate policies, forcing member states to adopt mandates that are strongly illiberal both in their principles and in their indirect consequences.

The experience in Germany is broadly similar, and discouraging. The Frankfurter Allgemeine Zeitung reported last week that the special measures required to guarantee security of electricity supply had in 2015 for the first time topped €1bn:The total cost for network operator Tennet in 2015 comes to 700 million euros – including 225 million euros (2014: 74 million) for the startup and shutdown of power plants, 152 million euros (2014: 92 million) for the retrieval of network reserve and 329 million ( 2014: 128 million) for the emergency shutdown of wind turbines. The second major network operators 50 Hertz, which has to transport a lot of wind power in northern and eastern Germany, recently announced spending on grid stability of the 300 million euros.[4]

Network charges in Germany, the FAZ reports, now account for about 20% of the price to consumers, a proportion that will have to rise. For while it is true that new power lines are being built, and these will reduce the need for constraint payments to wind, for example, the power lines will themselves have to be paid for by a charge on the consumer, roughly 5% to 10% of the capital cost of the asset for the lifetime of that asset. Grid reinforcements are very expensive.

As critics have long pointed out, the fact that the wind and the sun is free is little short of meaningless. – So is the fossil fuel in the ground. The costs for both are all in the extraction, conversion and delivery to consumers, with delivery, the system operation costs, being so high for renewables that any reductions in capital cost are dwarfed. The fact that these system costs are being imposed through instruments that are non-market, or only weakly competitive, not only adds insult to injury in the short term but promises a future in which the consumer is simply the victim of administrative pricing.